Historic Market Bailout Set in Motion

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Paulson: Fannie, Freddie to Buy More Mortgages

Treasury Secretary Henry Paulson says mortgage giants Fannie Mae and Freddie Mac will step up their purchases of mortgage-backed securities to help provide support to the crippled housing market.

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The Dow Jones industrial average, which jumped between massive losses and gains this week, rose 3.3 percent yesterday to close at 11,388.44. Combined with a 410-point gain Thursday, the index ended near break-even for the week -- sweeping away Monday's 504-point loss. The Standard & Poor's 500-stock index, a broader measure, rose 4 percent yesterday and actually posted a gain for the week.

"It's a massive relief rally on the back of the comprehensive plan," said Joseph Brusuelas, chief economist for Merk Investment. "If you have hundreds of millions of mortgage-backed securities on your books that you cannot value, much less sell, you can now unload them to the U.S. government."

Investors also moved out of the safety of Treasurys and back into the broader market. On the expectation that the economy will now recover, the price of light, sweet crude oil jumped $6.67, to $104.55 a barrel, on the New York Mercantile Exchange.

The proposals unveiled yesterday capped a dizzying two weeks in which the government seized the mortgage-finance giants Fannie Mae and Freddie Mac; allowed the 158-year-old Lehman Brothers to collapse; and taken over American International Group, the largest insurer in the world.

In his speech yesterday, Paulson identified the mortgage securities that the government would buy as the "underlying weakness in our financial system."

Mortgage securities provide the financing for most home loans sold in the United States and were widely held by big financial firms and banks. When home values started dropping, traditional buyers of these securities ran for the exits, and the value of the securities also plummeted. Those left holding the bag -- mainly mortgage firms, big Wall Street banks and hedge funds -- started to suffer vast losses, and some collapsed altogether.

Under the administration's plan, the Treasury would offer to buy the troubled mortgages from U.S. financial institutions. The Fed has been talking to its counterparts around the world to set up similar programs for other countries' banks.

The Treasury would hold several rounds of buying, first purchasing securities from the banks that request the lowest prices, in order to limit the cost to taxpayers. The plan could be broadened to include securities based on other kinds of loans, such as student loans and commercial real estate.

The U.S. government could end up holding the securities for years or even decades, depending on whether they recover value.

The troubled mortgage securities "are clogging up our financial system and undermining the strength of our otherwise sound financial institutions," Paulson said. "As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment and job creation has been disrupted."

Some Democrats said yesterday that they are pushing for the Treasury to help the homeowners whose mortgages the securities finance avoid foreclosure, a debate that is expected to play out next week.

The timing of the administration's plan reflected in part mounting concern about money-market mutual funds, which were widely regarded as safe havens until the bankruptcy of Lehman Brothers caused a major fund to post a loss this week. Officials feared a massive run as investors withdrew about $200 billion during the week, including $50 billion on Thursday, according to Crane Data, which tracks the industry.